Low oil prices have hurt, but Petronas is adapting

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This summer, Malaysia's Petroliam Nasional Berhad (Petronas) delivered the world's first floating liquefied natural gas facility, beating Shell's Prelude vessel by more than a year. PFLNG Satu will process up to 1.2m tonnes a year of LNG, from shallow waters in Malaysia's Kanowit gasfield, 180km offshore Sarawak.

Prelude will be three times bigger, but Petronas got there first. A second floating-LNG vessel, with processing capacity of 1.5m t/y, is under construction for use at the deep-water Rotan field and might be ready in the next two or three years. Once proved at Kanowit and Rotan, the technology could be rolled out to Malaysia's many other stranded gasfields or to projects overseas. Floating LNG, says Petronas, is a "game-changer".

Such achievements put Petronas in a select band of national oil companies (NOCs)-others include Saudi Aramco, Norway's Statoil and Brazil's Petrobras-with technology investments to rival the private sector. The state-owned oil and gas company is also heavily invested in Malaysia's deep-water sector and in a partnership with ExxonMobil in Southeast Asia's first large-scale enhanced oil recovery (EOR) venture-the $2.5bn Tapis project, offshore Terengganu. Petronas is also one of the world's biggest LNG producers and traders.

Ahead of the game

Its international reach also sets Petronas apart from the average NOC. It has upstream developments in more than 20 countries and its overseas operations are now large enough to consume more than half its upstream capital spending. It has considerable experience in global LNG trade, having delivered more than 9,000 cargoes to over 20 countries. Its downstream-oil presence-helpfully branded by its sponsorship of Mercedes's successful Formula 1 team-extends to more than 40 countries.

Yet life is far from perfect. With its high dependency on oil and petroleum-product sales, and smaller downstream operations than the main international oil companies (IOCs), Petronas has been clobbered by weak oil prices. The company tends to come off poorly in other comparisons with IOCs too. Its dependency on Malaysia for oil and gas reserves is high, for instance: it has 23.2bn barrels of oil equivalent in its domestic market, compared with 10bn boe overseas. Its status in world LNG is underpinned by its control of the industry of its home country-the world's third-biggest exporter, after Qatar and Australia. Similarly, its upstream business is anchored by a dominant domestic position. Among other uncertainties are Petronas's financial obligations to its shareholder, the state, which can be unpredictable. Assets in unstable countries such as South Sudan and Iraq have heightened exposure to geopolitical risk.

But its privileged position in Malaysia can equally be viewed as a blessing-the kind of which IOCs can only dream. At home, it runs 198 producing fields and 355 offshore platforms through 101 production-sharing contracts and six risk-sharing contracts. Combined capacity of the eight trains at its Malaysia LNG (MLNG) complex amounts to around 26m t/y. A ninth train at MLNG, with capacity of 3.6m t/y, will bring total Malaysian output capacity to around 30m t/y when it starts producing in the first quarter of next year. The company is trying to address other perceived weaknesses, broadening its liquefaction operations beyond Malaysia: it owns 27.5% of each of the two trains at newly commissioned Santos GLNG, a 7.8m t/y plant on Curtis Island, off Australia's east coast, which converts coal-seam gas into LNG. Petronas is among the off-takers too, expanding its global trading portfolio and taking advantage of established relationships with big LNG buyers in countries such as Japan, South Korea and Taiwan.

Assets in Australia also help cut geopolitical risk across the overseas portfolio. The same benefit would accrue if proposed investments in North America's fledgling LNG-export industry were to go ahead. Plans are to pipe gas produced by Petronas-owned Progress Energy in northeast British Columbia and northwest Alberta to an $11bn liquefaction plant on Lelu Island, near Prince Rupert, on Canada's west coast. Pacific NorthWest LNG would initially comprise two LNG trains, each with a capacity of around 6m t/y; a third, similarly sized train would be possible at a later stage. Construction was supposed to start last year, but regulatory approval has not been forthcoming, as the government continues to assess the project's likely impact on the local environment and First Nation groups. Petronas says it will reappraise market conditions and the project's economics in light of its regulatory obligations, once they are known, before it makes a final investment decision (FID)-probably around the end of the year. If it decides to go ahead, exports might start in 2020-21.

Gas assets

LNG accounted for just over a fifth of group revenue in 2015 and that could grow substantially as the company builds a greater overseas presence. Yet Pacific NorthWest LNG's future is in the balance: in April, Petronas's LNG marketing boss, Ahmad Adly Alias, said adverse LNG-trading conditions meant "some producers might pull the plug on LNG projects that have not gone through with their FID". Times are undoubtedly tough in the sector. Low energy prices have prompted lead partner Santos to write down its investment in Santos GLNG by just over $1bn. Petronas has suffered too, in LNG and across its upstream businesses. A bad 2015 continued into the first half of 2016: in the second quarter, group profit slumped by 85% to RM1.62bn ($402m), from RM11.07bn in the second quarter of 2015. Revenue was down by 21% compared with the same period the year before, to RM48.4bn. Impairment charges rose by a factor of almost 15, reaching RM7.16bn. Even downstream suffered: while upstream presented the most dramatic reverse-converting an after-tax profit of RM6.17bn a year ago into a net loss of RM3.71bn in three months to end-June 2016-downstream profit also slipped, from RM3.29bn a year ago to RM2.26bn.

Low commodity prices are the chief culprit, but sales volumes of crude oil and condensate, gas and petroleum products-at 1.648m boe a day in the second quarter-have fallen too. And, other than favourable currency movements, there seems to be no immediate cause for optimism. Chief executive Wan Zulkiflee Wan Ariffin has described the outlook as "gloomy", well into 2017, blaming over-supply, growing inventories and sluggish demand growth.

Petronas isn't hanging around in the hope things will get better, though. A cost-cutting drive implemented in response to the oil-price collapse has already saved RM3.4bn. The company plans to cut capital and operating spending by RM50bn over four years and may achieve a reduction of RM20bn in 2016 alone.

Despite the recent rise in the oil price, it remains cautious: cost-cutting efforts will be retained even if prices recover; and it is sticking to a conservative planning figure for Brent crude, of $30 a barrel. Moody's Investors Service describes Petronas's liquidity profile as "excellent" and says the recent oil-price recovery, combined with cost-control efforts, could bump up this year's earnings. The credit-ratings agency is also unperturbed by Petronas's commitment to pay the state's full RM16bn dividend this year, even though that might lead to further borrowing or dipping into cash reserves.

Nonetheless, constrained capital spending and relatively weak oil prices mean the company may struggle to maintain momentum in upstream growth, with marginal field development, EOR and deep-water projects all under pressure. That makes its focus on downstream expansion timely. At present, Petronas has 0.5m b/d of refining capacity, spread across four refineries-three in Malaysia and one in South Africa. But by 2019 the capacity figure could rise to 0.8m b/d, with the planned completion of the $16bn Refinery and Petrochemical Integrated Development (Rapid) project in the southern state of Johor-part of the Pengerang Integrated Complex. As well as a 300,000 b/d refinery, Rapid will have a 7.7m t/y petrochemicals complex, producing a variety of products, including lucrative specialty chemicals.

Rapid should enable Malaysia's only Fortune 500 company to capitalise on the country's prime location on one of the world's busiest shipping lanes-developing a regional petrochemicals hub that could provide neighbouring Singapore with competition. This is ambitious-but characteristic of an NOC that is, in some ways, in a class of its own.